ISBN 92-64-10812-2 OECD Employment Outlook © OECD 2004 OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 2004 61 Chapter 2 Employment Protection Regulation and Labour Market Performance Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Main findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 1. Employment protection regulation in OECD countries . . . . . . . . . . . . . . . . 64 2. Links between EPL, labour market dynamics and labour market outcomes for different groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 3. Making the most of EPL: preliminary considerations . . . . . . . . . . . . . . . . . 89 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 Annex 2.A1. Calculation of Summary Indicators of EPL Strictness . . . . . . . . 102 Annex 2.A2. Employment Protection Legislation Indices . . . . . . . . . . . . . . . . 107 Annex 2.A3. Data Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123 There has been heated policy debate on the costs and benefits of regulations governing dismissals and other features of employment protection. The key issue is how to keep a balance between the need for firms to adapt to ever-changing market conditions on the one hand, and workers’ employment security on the other. Do employment protection regulations have an impact on firms’ hiring and firing decisions and is this impact different across demographic groups? Do such regulations explain the high incidence of temporary work recorded in certain countries? How to instil labour market dynamism while also protecting workers against job and income loss?
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OECD Employment OutlookChapter 2
Employment Protection Regulation and Labour Market Performance
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Main findings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 1. Employment protection regulation in OECD countries . . . . . . . . . . . . . . . . 64 2. Links between EPL, labour market dynamics and labour market
outcomes for different groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 3. Making the most of EPL: preliminary considerations . . . . . . . . . . . . . . . . . 89 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
Annex 2.A1. Calculation of Summary Indicators of EPL Strictness . . . . . . . . 102 Annex 2.A2. Employment Protection Legislation Indices . . . . . . . . . . . . . . . . 107 Annex 2.A3. Data Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123
There has been heated policy debate on the costs and benefits of regulations governing dismissals and other features of employment protection. The key issue is how to keep a balance between the need for firms to adapt to ever-changing market conditions on the one hand, and workers’ employment security on the other. Do employment protection regulations have an impact on firms’ hiring and firing decisions and is this impact different across demographic groups? Do such regulations explain the high incidence of temporary work recorded in certain countries? How to instil labour market dynamism while also protecting workers against job and income loss?
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 200462
Introduction As with most labour market regulations, employment protection legislation (EPL) was
first introduced with the aim of enhancing workers’ welfare and improving employment
conditions. However, the same provisions that protect employees translate into a cost for
employers and thus could have a negative impact on hiring. The literature on EPL highlights
positive and negative effects on labour market performance. Among the former, it highlights
the benefits of long-term employee-employer contracts including greater willingness to
invest in on-the-job training. Among the latter, is the concern that workers hired on regular
contracts may enjoy a high degree of employment security to the detriment of other workers
hired on temporary contracts. In addition, employment protection may diminish firms’
ability to cope with a rapidly changing environment driven by globalisation, technological
change and the derived organisational innovation. The effects of EPL on labour market
performance are a controversial subject, both in theory and in applied research.
Most available studies have looked at employment protection as an additional labour
cost for firms, and have studied the effects of this cost on employment and joblessness, but
two important and related aspects have often been left aside: i) the rationale for the
existence of employment protection; and ii) its welfare consequences. Some recent studies
have sought to address these issues by considering employment protection not just as an
exogenous cost for employers, but as a comprehensive policy instrument, able to resolve
certain market imperfections, with potential positive welfare implications. Policy
recommendations have also evolved towards a more balanced view of the dilemma
opposing the need for flexibility expressed by firms to the importance of protecting
workers against labour market risks. For instance, the European Commission has recently
recommended to EU member states “to review and, where appropriate, reform overly
restrictive elements of employment legislation” while “taking account of the need for both
flexibility and security” (European Commission, 2003a). The ILO has set similar objectives
with the aim of promoting employment stability while maintaining a sufficient level of
labour market flexibility.
Within the context of the OECD Jobs Strategy re-assessment, it is important to review
the issue of employment protection in the light of these recent developments. This chapter
starts by presenting a picture of current employment protection regulations in OECD
countries. The second section studies the effects of EPL on labour market performance,
trying to identify the socio-demographic groups that seem to benefit from it and those
who, by contrast, appear to be penalised. The third part looks at the economic rationale for
employment protection, and discusses its role as one of the instruments available to
governments to protect workers against labour market risks, along with unemployment
benefit systems and active labour market policies.
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 2004 63
Main findings Over the past 15 years, a process of convergence across OECD countries has taken place as regards
EPL. This process has been driven largely by an easing of regulation in the countries where
EPL was relatively strict at the end of the 1980s. In most cases, these reforms consisted in
easing the recourse to temporary forms of employment while leaving existing provisions
for regular or permanent contracts practically unaltered. Despite this convergence, the
relative position of countries across the overall spectrum of EPL strictness, as defined and
measured by the OECD, has not changed much since the late 1980s. The overall strictness
of EPL continues to vary widely between countries and the regulation of temporary
employment remains a key element in explaining cross-countries differences.
Employment protection regulation fulfils its stated purpose, namely protecting existing jobs. Indeed
evidence presented in this chapter suggests that EPL tends to limit firms’ ability to fire
workers. At the same time, EPL would reduce the re-employment chances of unemployed workers
– thereby exerting upward pressure on long-term unemployment. Indeed, in deciding
whether to hire a worker, employers will take into account the likelihood that firing costs
will be incurred in the future. In sum, EPL leads to two opposite effects on labour market
dynamics: it reduces inflows into unemployment, while also making it more difficult for
jobseekers to enter employment (i.e. lower outflows from unemployment).
The net impact of EPL on aggregate unemployment is therefore ambiguous a priori, and can only be
resolved by empirical investigation. However, the numerous empirical studies of this issue
lead to conflicting results, and moreover their robustness has been questioned. On the
other hand, it is possible to detect a link between EPL and employment rates for specific
groups. Some studies, as well as the analysis presented in this chapter, suggest the
possibility of a negative link between strict EPL and the employment rates of youth and
prime-age women, while there may be positive links to the employment rates of other
groups. This is consistent with the above findings of the effects of EPL on labour market
dynamics. Indeed youth and prime-age women are more likely to be subject to entry
problems in the labour market than is the case with other groups, and they are therefore
likely to be disproportionately affected by the effects of EPL on firms’ hiring decisions.
Differences in the strictness of EPL for regular and temporary jobs may be an important element
in explaining the rise in the incidence of temporary work for youth and the low skilled (this is less
the case for other groups, notably prime-age men). This means that facilitating the use
of temporary work arrangements, while not changing EPL on regular employment, may
aggravate labour market duality. It may also affect career progression and productivity of
workers trapped in temporary forms of employment, which are typically characterised
by weak job attachments and limited opportunities for upgrading human capital.
Any overall assessment of EPL has to weigh costs against benefits. EPL may foster long-term
employment relationships, thus promoting workers’ effort, co-operation and willingness
to be trained, which is positive for aggregate employment and economic efficiency.
In addition, by promoting firms’ social responsibility in the face of adjustment to
unfavourable economic circumstances, a reasonable degree of employment protection
could be welfare-improving, i.e. it can help balance concern for workers’ job security
with the need for labour market adjustment and dynamism. Thus, some recent studies
suggest that an optimal policy would combine some EPL with effective re-employment
services and active labour market policies aiming at counteracting the negative effects
of EPL on firms’ hiring decisions.
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 200464
The precise balance between the different policy planks (EPL, unemployment benefits and
active labour market policies) depends on country circumstances and institutions. For
instance, in Denmark, employment services seem to be rather effective in “activating”
benefit recipients while EPL is moderate in this country – the so-called “flexicurity”
approach. Such a policy mix has helped guarantee sufficient dynamism in the
labour market, while ensuring adequate employment security among workers. In the
United States, experience-rating, which links employers’ social security contributions to
the layoff history of the firm, was introduced to prevent firms from taking advantage of
temporary layoffs in response to cyclical downturns in labour demand. Some evaluation
studies of the system in the United States lend support to this policy initiative, in terms
of lower unemployment as well as greater job stability, in that experience-rating seems
to have reduced the cyclicality of employment. More generally, further analysis of the
policy interactions involved is clearly called for as part of the reassessment of the OECD
Jobs Strategy.
1. Employment protection regulation in OECD countries Since the seminal paper by Lazear was published in 1990, empirical studies on the
effects of EPL on labour market outcomes have proliferated. In order to facilitate this task,
constructing a good measure of these regulations has become of crucial importance. The
OECD tackled the task in 1999, updating the work done by Grubb and Wells (1993) and
extending it to include more dimensions of employment regulation, notably the regulation
of collective dismissals. Despite some limitations, the OECD indicator still represents an
improvement over the simple measure of severance pay used in the first papers of this
literature.1 Besides, it has been shown to be consistent with several proposed alternative
measures ranging from employers’ surveys that ask managers to rank the “flexibility of the
enterprise to adjust job security to economic reality” to measures of broader-based indices
of economic freedom (Addison and Teixeira, 2003).
A. Looking into the black box
Employment protection regulation, a set of rules governing the hiring and firing
process, can be provided through both labour legislation and collective bargaining
agreements. In addition, it is important to distinguish these rules from practice, which
brings in the enforcement dimension. Therefore, when discussing the extent of
employment protection, judicial practices and court interpretations of legislative and
contractual rules have to be taken into account as well. The measure of employment
protection developed in this chapter is mainly based on legislative provisions, but it also
incorporates some aspects of contractual provisions and judicial practices. Nevertheless,
given that collective agreements and courts’ decisions often refer to a wide range of rules
set on a case-by-case basis, their role is likely to be somewhat understated in the
information presented here.
The three main components of the indicator
The indicator of employment protection in this chapter follows the approach
developed in Chapter 2 of the 1999 edition of the OECD Employment Outlook, thereby
allowing comparisons over time. It refers to the protection of regular employment and the
regulation of temporary work and is intended to measure the strictness of EPL. More precisely,
since most of the literature on employment protection emphasises the analogy of EPL to an
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 2004 65
employer-borne tax on employment adjustment, the overall intent is to reflect the cost
implications of various regulatory provisions for employers (i.e. stricter is interpreted as
more costly). The overall summary measure of EPL strictness relies on three main
components related to protection of regular workers against (individual) dismissal, specific
requirements for collective dismissals and regulation of temporary forms of employment:2
In order to assess job protection of workers with regular contracts, three main areas are
considered: i) difficulty of dismissal, that is legislative provisions setting conditions
under which a dismissal is “justified” or “fair”; ii) procedural inconveniences that the
employer may face when starting the dismissal process; iii) and notice and severance
pay provisions. Regular employment contracts do not generally specify any duration for
the employment relationship. Part of the role of the EPL is thus to define “just causes” or
“serious reasons” for the termination of an employment relationship and the sanctions
applicable to the employer in case of non-respect of this principle of just cause
termination. In other words, these provisions set conditions under which it is possible
for an employer to dismiss an employee. Procedural inconveniences can be seen as a
complement to these provisions. Indeed, they may give the opportunity to the employee
to challenge the layoff decision at an early stage of the process. These procedures may
also involve a third party (such as a works’ council or the competent labour authority),
usually not empowered to stop the process but that can nevertheless help to avoid the
dismissal. When the dismissal is certain, notice and severance pay provisions are then
the final costs for the employer.
Considering that collective dismissals may have a social cost, additional provisions have
been introduced in almost all OECD countries to minimise this cost. The related
component of the EPL index presented in this chapter only refers to additional delays and
procedures required which go beyond those applicable for individual dismissal, and does
not reflect the overall strictness of regulation applicable to collective dismissals. Indeed,
whatever the number of additional requirements, collective dismissals are de facto
strongly regulated when the regulation of individual dismissals is itself relatively strict.
Finally, provisions regarding fixed-term contracts and temporary work agencies are also
considered. This component of the EPL index is intended to measure the restrictions on
the use of temporary employment by firms, with respect to the type of work for which
these contracts are allowed and their duration.
Protection of regular contracts against (individual) dismissal constitutes the core
component of the overall summary index of EPL strictness presented in this chapter.
Indeed, although temporary forms of employment have grown in many OECD countries
over the past two decades, regular contracts are still the most common employment
arrangement (OECD, 2002a, Chapter 3). Temporary work is sometimes regarded as a way to
circumvent rules governing regular contracts. For the component related to collective
dismissals, the story is quite different: by construction, it includes only regulation
applicable in addition to that applied in cases of individual dismissals and cannot therefore
be considered as a stand-alone component of EPL.
Limits of the indicator: the role of contractual provisions and judicial practices
Some potentially important aspects of employment protection are difficult to take into
account in the EPL indicator. This is, for instance, the case for trial or probationary periods,
which are often not legally required although permitted by law. The length of the trial
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 200466
period is important because, during this period, regular contracts are not fully covered by
employment protection provisions and usually unfair dismissal claims cannot be made
during probation. Legislative provisions may set a maximum duration but, in practice, the
length of the trial period is provided in either individual employment contracts or
collective agreements. Probationary periods exist in most OECD countries and in many
cases, the corresponding EPL index refers to these contractual provisions.
To take another example, in some countries, notice periods and/or severance pay are
not legally regulated. Instead, they can be provided by collective agreements and individual
contractual clauses. Moreover, even in the large number of countries where there are legal
requirements, the latter can be extended by contractual provisions (Box 2.1). However, in
countries for which data are available, the coverage of such additional provisions is very
low compared with legal provisions that usually relate to all workers with regular
contracts. Moreover, in many cases there is simply no detailed information available on
such contractual practices. As a consequence, the summary measures of EPL strictness
developed in this chapter often rely on minimal requirements set by legislative provisions.
For regular contracts, employment protection regulations set rules under which an
employee can be dismissed, and the employer can be sanctioned in case of non-respect of
these rules. However, these provisions are subject to court interpretations and this may
constitute a major (but often hidden) source of variation in EPL strictness both across
countries and over time. Recent studies suggest that jurisprudence may be affected by the
underlying labour market conditions; for instance, there is some evidence that judge’s
decisions may tend to be particularly unfavourable to employers when unemployment is
high (Ichino et al., 2003; Bertola et al., 1999). Moreover, compensation for unfair dismissal
set by courts can deviate widely from the minima set out in legislation, since judges may
account in their final decision for damages corresponding to past and expected future
financial losses and psychological damage. The related measures of EPL strictness (namely
the two first-level indices, “compensation following unfair dismissal” and “extent of
reinstatement”) reflect to some extent these judicial practices, provided that information
was available at the time of writing.
Although court decisions are potentially important to evaluate how binding
employment protection regulations are in practice, preliminary statistics on case numbers
and conciliation practices suggest that they may play mainly a threatening role. Indeed, few
cases seem to be brought before the courts each year (Table 2.1).3 In appeals to the court,
workers are not in a particularly favourable situation, despite often benefiting from the
assistance of trade unions. In several countries, the judicial procedure may be very long,
from six months to more than one year, while the percentage of cases won by workers is
often around 50%, adding uncertainty on both the side of the employee and the employer
concerning the outcome of any case. The uncertainty over the court ruling and the length of
the procedure may be an incentive to reach a bilateral agreement, through mediation and
conciliation. In this respect, the most striking fact…
Employment Protection Regulation and Labour Market Performance
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Main findings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 1. Employment protection regulation in OECD countries . . . . . . . . . . . . . . . . 64 2. Links between EPL, labour market dynamics and labour market
outcomes for different groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 3. Making the most of EPL: preliminary considerations . . . . . . . . . . . . . . . . . 89 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
Annex 2.A1. Calculation of Summary Indicators of EPL Strictness . . . . . . . . 102 Annex 2.A2. Employment Protection Legislation Indices . . . . . . . . . . . . . . . . 107 Annex 2.A3. Data Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123
There has been heated policy debate on the costs and benefits of regulations governing dismissals and other features of employment protection. The key issue is how to keep a balance between the need for firms to adapt to ever-changing market conditions on the one hand, and workers’ employment security on the other. Do employment protection regulations have an impact on firms’ hiring and firing decisions and is this impact different across demographic groups? Do such regulations explain the high incidence of temporary work recorded in certain countries? How to instil labour market dynamism while also protecting workers against job and income loss?
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 200462
Introduction As with most labour market regulations, employment protection legislation (EPL) was
first introduced with the aim of enhancing workers’ welfare and improving employment
conditions. However, the same provisions that protect employees translate into a cost for
employers and thus could have a negative impact on hiring. The literature on EPL highlights
positive and negative effects on labour market performance. Among the former, it highlights
the benefits of long-term employee-employer contracts including greater willingness to
invest in on-the-job training. Among the latter, is the concern that workers hired on regular
contracts may enjoy a high degree of employment security to the detriment of other workers
hired on temporary contracts. In addition, employment protection may diminish firms’
ability to cope with a rapidly changing environment driven by globalisation, technological
change and the derived organisational innovation. The effects of EPL on labour market
performance are a controversial subject, both in theory and in applied research.
Most available studies have looked at employment protection as an additional labour
cost for firms, and have studied the effects of this cost on employment and joblessness, but
two important and related aspects have often been left aside: i) the rationale for the
existence of employment protection; and ii) its welfare consequences. Some recent studies
have sought to address these issues by considering employment protection not just as an
exogenous cost for employers, but as a comprehensive policy instrument, able to resolve
certain market imperfections, with potential positive welfare implications. Policy
recommendations have also evolved towards a more balanced view of the dilemma
opposing the need for flexibility expressed by firms to the importance of protecting
workers against labour market risks. For instance, the European Commission has recently
recommended to EU member states “to review and, where appropriate, reform overly
restrictive elements of employment legislation” while “taking account of the need for both
flexibility and security” (European Commission, 2003a). The ILO has set similar objectives
with the aim of promoting employment stability while maintaining a sufficient level of
labour market flexibility.
Within the context of the OECD Jobs Strategy re-assessment, it is important to review
the issue of employment protection in the light of these recent developments. This chapter
starts by presenting a picture of current employment protection regulations in OECD
countries. The second section studies the effects of EPL on labour market performance,
trying to identify the socio-demographic groups that seem to benefit from it and those
who, by contrast, appear to be penalised. The third part looks at the economic rationale for
employment protection, and discusses its role as one of the instruments available to
governments to protect workers against labour market risks, along with unemployment
benefit systems and active labour market policies.
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 2004 63
Main findings Over the past 15 years, a process of convergence across OECD countries has taken place as regards
EPL. This process has been driven largely by an easing of regulation in the countries where
EPL was relatively strict at the end of the 1980s. In most cases, these reforms consisted in
easing the recourse to temporary forms of employment while leaving existing provisions
for regular or permanent contracts practically unaltered. Despite this convergence, the
relative position of countries across the overall spectrum of EPL strictness, as defined and
measured by the OECD, has not changed much since the late 1980s. The overall strictness
of EPL continues to vary widely between countries and the regulation of temporary
employment remains a key element in explaining cross-countries differences.
Employment protection regulation fulfils its stated purpose, namely protecting existing jobs. Indeed
evidence presented in this chapter suggests that EPL tends to limit firms’ ability to fire
workers. At the same time, EPL would reduce the re-employment chances of unemployed workers
– thereby exerting upward pressure on long-term unemployment. Indeed, in deciding
whether to hire a worker, employers will take into account the likelihood that firing costs
will be incurred in the future. In sum, EPL leads to two opposite effects on labour market
dynamics: it reduces inflows into unemployment, while also making it more difficult for
jobseekers to enter employment (i.e. lower outflows from unemployment).
The net impact of EPL on aggregate unemployment is therefore ambiguous a priori, and can only be
resolved by empirical investigation. However, the numerous empirical studies of this issue
lead to conflicting results, and moreover their robustness has been questioned. On the
other hand, it is possible to detect a link between EPL and employment rates for specific
groups. Some studies, as well as the analysis presented in this chapter, suggest the
possibility of a negative link between strict EPL and the employment rates of youth and
prime-age women, while there may be positive links to the employment rates of other
groups. This is consistent with the above findings of the effects of EPL on labour market
dynamics. Indeed youth and prime-age women are more likely to be subject to entry
problems in the labour market than is the case with other groups, and they are therefore
likely to be disproportionately affected by the effects of EPL on firms’ hiring decisions.
Differences in the strictness of EPL for regular and temporary jobs may be an important element
in explaining the rise in the incidence of temporary work for youth and the low skilled (this is less
the case for other groups, notably prime-age men). This means that facilitating the use
of temporary work arrangements, while not changing EPL on regular employment, may
aggravate labour market duality. It may also affect career progression and productivity of
workers trapped in temporary forms of employment, which are typically characterised
by weak job attachments and limited opportunities for upgrading human capital.
Any overall assessment of EPL has to weigh costs against benefits. EPL may foster long-term
employment relationships, thus promoting workers’ effort, co-operation and willingness
to be trained, which is positive for aggregate employment and economic efficiency.
In addition, by promoting firms’ social responsibility in the face of adjustment to
unfavourable economic circumstances, a reasonable degree of employment protection
could be welfare-improving, i.e. it can help balance concern for workers’ job security
with the need for labour market adjustment and dynamism. Thus, some recent studies
suggest that an optimal policy would combine some EPL with effective re-employment
services and active labour market policies aiming at counteracting the negative effects
of EPL on firms’ hiring decisions.
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 200464
The precise balance between the different policy planks (EPL, unemployment benefits and
active labour market policies) depends on country circumstances and institutions. For
instance, in Denmark, employment services seem to be rather effective in “activating”
benefit recipients while EPL is moderate in this country – the so-called “flexicurity”
approach. Such a policy mix has helped guarantee sufficient dynamism in the
labour market, while ensuring adequate employment security among workers. In the
United States, experience-rating, which links employers’ social security contributions to
the layoff history of the firm, was introduced to prevent firms from taking advantage of
temporary layoffs in response to cyclical downturns in labour demand. Some evaluation
studies of the system in the United States lend support to this policy initiative, in terms
of lower unemployment as well as greater job stability, in that experience-rating seems
to have reduced the cyclicality of employment. More generally, further analysis of the
policy interactions involved is clearly called for as part of the reassessment of the OECD
Jobs Strategy.
1. Employment protection regulation in OECD countries Since the seminal paper by Lazear was published in 1990, empirical studies on the
effects of EPL on labour market outcomes have proliferated. In order to facilitate this task,
constructing a good measure of these regulations has become of crucial importance. The
OECD tackled the task in 1999, updating the work done by Grubb and Wells (1993) and
extending it to include more dimensions of employment regulation, notably the regulation
of collective dismissals. Despite some limitations, the OECD indicator still represents an
improvement over the simple measure of severance pay used in the first papers of this
literature.1 Besides, it has been shown to be consistent with several proposed alternative
measures ranging from employers’ surveys that ask managers to rank the “flexibility of the
enterprise to adjust job security to economic reality” to measures of broader-based indices
of economic freedom (Addison and Teixeira, 2003).
A. Looking into the black box
Employment protection regulation, a set of rules governing the hiring and firing
process, can be provided through both labour legislation and collective bargaining
agreements. In addition, it is important to distinguish these rules from practice, which
brings in the enforcement dimension. Therefore, when discussing the extent of
employment protection, judicial practices and court interpretations of legislative and
contractual rules have to be taken into account as well. The measure of employment
protection developed in this chapter is mainly based on legislative provisions, but it also
incorporates some aspects of contractual provisions and judicial practices. Nevertheless,
given that collective agreements and courts’ decisions often refer to a wide range of rules
set on a case-by-case basis, their role is likely to be somewhat understated in the
information presented here.
The three main components of the indicator
The indicator of employment protection in this chapter follows the approach
developed in Chapter 2 of the 1999 edition of the OECD Employment Outlook, thereby
allowing comparisons over time. It refers to the protection of regular employment and the
regulation of temporary work and is intended to measure the strictness of EPL. More precisely,
since most of the literature on employment protection emphasises the analogy of EPL to an
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 2004 65
employer-borne tax on employment adjustment, the overall intent is to reflect the cost
implications of various regulatory provisions for employers (i.e. stricter is interpreted as
more costly). The overall summary measure of EPL strictness relies on three main
components related to protection of regular workers against (individual) dismissal, specific
requirements for collective dismissals and regulation of temporary forms of employment:2
In order to assess job protection of workers with regular contracts, three main areas are
considered: i) difficulty of dismissal, that is legislative provisions setting conditions
under which a dismissal is “justified” or “fair”; ii) procedural inconveniences that the
employer may face when starting the dismissal process; iii) and notice and severance
pay provisions. Regular employment contracts do not generally specify any duration for
the employment relationship. Part of the role of the EPL is thus to define “just causes” or
“serious reasons” for the termination of an employment relationship and the sanctions
applicable to the employer in case of non-respect of this principle of just cause
termination. In other words, these provisions set conditions under which it is possible
for an employer to dismiss an employee. Procedural inconveniences can be seen as a
complement to these provisions. Indeed, they may give the opportunity to the employee
to challenge the layoff decision at an early stage of the process. These procedures may
also involve a third party (such as a works’ council or the competent labour authority),
usually not empowered to stop the process but that can nevertheless help to avoid the
dismissal. When the dismissal is certain, notice and severance pay provisions are then
the final costs for the employer.
Considering that collective dismissals may have a social cost, additional provisions have
been introduced in almost all OECD countries to minimise this cost. The related
component of the EPL index presented in this chapter only refers to additional delays and
procedures required which go beyond those applicable for individual dismissal, and does
not reflect the overall strictness of regulation applicable to collective dismissals. Indeed,
whatever the number of additional requirements, collective dismissals are de facto
strongly regulated when the regulation of individual dismissals is itself relatively strict.
Finally, provisions regarding fixed-term contracts and temporary work agencies are also
considered. This component of the EPL index is intended to measure the restrictions on
the use of temporary employment by firms, with respect to the type of work for which
these contracts are allowed and their duration.
Protection of regular contracts against (individual) dismissal constitutes the core
component of the overall summary index of EPL strictness presented in this chapter.
Indeed, although temporary forms of employment have grown in many OECD countries
over the past two decades, regular contracts are still the most common employment
arrangement (OECD, 2002a, Chapter 3). Temporary work is sometimes regarded as a way to
circumvent rules governing regular contracts. For the component related to collective
dismissals, the story is quite different: by construction, it includes only regulation
applicable in addition to that applied in cases of individual dismissals and cannot therefore
be considered as a stand-alone component of EPL.
Limits of the indicator: the role of contractual provisions and judicial practices
Some potentially important aspects of employment protection are difficult to take into
account in the EPL indicator. This is, for instance, the case for trial or probationary periods,
which are often not legally required although permitted by law. The length of the trial
2. EMPLOYMENT PROTECTION REGULATION AND LABOUR MARKET PERFORMANCE
OECD EMPLOYMENT OUTLOOK – ISBN 92-64-10812-2 – © OECD 200466
period is important because, during this period, regular contracts are not fully covered by
employment protection provisions and usually unfair dismissal claims cannot be made
during probation. Legislative provisions may set a maximum duration but, in practice, the
length of the trial period is provided in either individual employment contracts or
collective agreements. Probationary periods exist in most OECD countries and in many
cases, the corresponding EPL index refers to these contractual provisions.
To take another example, in some countries, notice periods and/or severance pay are
not legally regulated. Instead, they can be provided by collective agreements and individual
contractual clauses. Moreover, even in the large number of countries where there are legal
requirements, the latter can be extended by contractual provisions (Box 2.1). However, in
countries for which data are available, the coverage of such additional provisions is very
low compared with legal provisions that usually relate to all workers with regular
contracts. Moreover, in many cases there is simply no detailed information available on
such contractual practices. As a consequence, the summary measures of EPL strictness
developed in this chapter often rely on minimal requirements set by legislative provisions.
For regular contracts, employment protection regulations set rules under which an
employee can be dismissed, and the employer can be sanctioned in case of non-respect of
these rules. However, these provisions are subject to court interpretations and this may
constitute a major (but often hidden) source of variation in EPL strictness both across
countries and over time. Recent studies suggest that jurisprudence may be affected by the
underlying labour market conditions; for instance, there is some evidence that judge’s
decisions may tend to be particularly unfavourable to employers when unemployment is
high (Ichino et al., 2003; Bertola et al., 1999). Moreover, compensation for unfair dismissal
set by courts can deviate widely from the minima set out in legislation, since judges may
account in their final decision for damages corresponding to past and expected future
financial losses and psychological damage. The related measures of EPL strictness (namely
the two first-level indices, “compensation following unfair dismissal” and “extent of
reinstatement”) reflect to some extent these judicial practices, provided that information
was available at the time of writing.
Although court decisions are potentially important to evaluate how binding
employment protection regulations are in practice, preliminary statistics on case numbers
and conciliation practices suggest that they may play mainly a threatening role. Indeed, few
cases seem to be brought before the courts each year (Table 2.1).3 In appeals to the court,
workers are not in a particularly favourable situation, despite often benefiting from the
assistance of trade unions. In several countries, the judicial procedure may be very long,
from six months to more than one year, while the percentage of cases won by workers is
often around 50%, adding uncertainty on both the side of the employee and the employer
concerning the outcome of any case. The uncertainty over the court ruling and the length of
the procedure may be an incentive to reach a bilateral agreement, through mediation and
conciliation. In this respect, the most striking fact…
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